Economy: Do deficits still matter?

The debt clock might be a ticking time bomb.(Getty)

The national debt hit $22 trillion last week, but there’s little pressure on the government to rein in spending, said David Harrison and Kate Davidson in The Wall Street Journal. Annual deficits will top $1 trillion starting in 2022, and the Congressional Budget Office projects the U.S. government’s debt could reach 93 percent of GDP—the country’s total annual economic production—by the end of the next decade. That’s a key threshold; one influential study “found that countries with debt loads greater than 90 percent of GDP tended to have slower growth rates.” So far, though, the run-up in debt hasn’t seemed to hurt the economy. Investors have been happy to “keep lending to the U.S. in good times and bad, regardless of how much it borrows.” All the big increases in government spending haven’t caused a spike in inflation, either. “Now some prominent economists say U.S. deficits don’t matter so much after all.”

For years economists scolded countries for borrowing too much, said Noah Smith in Bloomberg.com. These days, however, many of them think that as long as interest rates are lower than the economy’s rate of growth, the government debt burden will effectively “shrink all on its own.” If that’s true, the U.S. “can afford to add some debt—say, another 60 percent of GDP—to its books with little danger.” At some point, “fiscal prudence will have to re-enter the conversation.” For now, though, the latest research shows that, in effect, we can keep borrowing at current levels up to the year 2043.

Here’s what will happen if we do that, said William Gale in CNN.com: “The problem will be bigger, the economic consequences will be more severe, and the political challenges of cutting spending and raising taxes will grow.” It’s fashionable now to say that deficits no longer matter and so we can embark on massive new programs of government spending like the Green New Deal and “Medicare for all.” Meanwhile, we’re accumulating the worst sort of debts—not ones for investing in infrastructure and education, but the kind that come from “an aging population and large, poorly targeted tax cuts.” Eventually, these deficits will choke off investment and savings. The longer we wait to address the record deficits, the more painful the adjustment will be.

If government debt really becomes a problem, we’ll know very quickly, said Jason Furman and Lawrence Summers in Foreign Affairs. “The financial markets give immediate feedback about the seriousness of the budget deficit.” But we’re not there now, and probably not anywhere close. With low interest rates, there’s no magic number at which government debt is too big. Japan’s national debt has been well over 100 percent of its GDP for almost two decades with no ill effects. The moment investors think it’s gotten harder for the U.S. to pay its debts, interest rates will rise, signaling that we need to cut spending or raise taxes. “But no alarm bells ring when the government fails to rebuild decaying infrastructure, properly fund preschools, or provide access to health care.” ■